Question

Suppose you are faced with choosing between two mutually exclusive projects. Your boss asked you to use the Replacement Chain method. The first project offers cash flows of $15,000 in years one and two, and $20,000 in years three, four, and five. It has an initial cost of $25,000. The second project offers cash flows of $25,000 per year for four years, and then $45,000 per year for six additional years (total project life of 10 years). It has an initial cost of $18,000. The firm has a weighted average cost of capital of 10%. Which project should the firm accept?

Answer 1

And Method) 6 yrs any Comporing projects with unequal woeful life ( Replacement Charming WACC = 10% . Profect ! Project 2 Life oyrs Toyrs. → Computing NPV of project : 2 NPV = PV of Cash Infloros - PV of cash out flores - $25,000x PVAF(106,4 yrs) $18.000 1$ 45,00% PVAF (10%., 5 bologni - $ 18,000 * PUAF (10]. ,5 to 10yrs) = PUAF(10%, loys) - PUAF(106, 4yrs) | = 6.1446 - 3.1699 = 2.9747 NPV = ($25000 * 3.1699) [ + ($45,000 x 2.9747) $ 213,109 - $ 18,00 $ 195,109] Computing NPV of Project: I : As Life of Proffject I is only 5 years but life of projecta 's lo years, it is assumed that an equal amount of cash flows of first 5 years will flow in next 5 years PV of Cash Outfloco! $ 25000 + (+25,000 PUF(10%, 5yrs] = $25000 + ($25000 x 0:621) - $ 40,525

pv of Cash Inflow! Year Cash inflow PVE PV 0.909 15,000 15,000 13,635 12,390 0826 20,000 15,020 20,000 15,000 15,000 20,000 20,000 ) 20,000 20,000 0 761 0.683 0.621 0.664 0.513 01467 0.424 0.386 13,660 12,420 8,460 7,695 9340 8,480 7720 10 (H pv of Cash Inflow → $1,08,820 ..NOW = pv of ash Inflow - Pu of Cash Outflow = $ 108,820 - $40,525 = $ 68,295 Comparing Projects: NPV , [2 $ 68,295 $ 195,109 [ As projects are mutually exclusive, project with higher NPV should be selected i profect 2 should be selected.